The US government shut down a series of court cases arising from a multimillion pound business dispute in order to conceal evidence of a damning intelligence failure shortly before the 9/11 attacks, MPs were told.

Moreover, the UK government is now seeking similar powers that could be used to prevent evidence of illegal acts and embarrassing failures from emerging in court, David Davis, the former shadow home secretary, told the Commons.

The Justice and Security green paper being put forward by Ken Clarke’s justice ministry has already faced widespread criticism from civil rights groups, media representatives and lawyers working within the secret tribunal system that hears terrorism-related immigration cases.

Davis demanded to know how its proposals could be prevented from being used to cover up crimes and errors. “In light of previous revelations about the UK government’s complicity in torture and rendition of detainees to locations like of Libya, Afghanistan, or illegally into American hands … how will the Government prevent the Justice and Security green paper proposals being misused in a similar way to cover up illegal acts and embarrassments rather than protect national security?”

Davis said that in 1998 the FBI seized upon an opportunity to eavesdrop on every landline and telephone call into and out of Afghanistan in a bid to build intelligence on the Taliban. The Bureau discovered that the Taliban regime had awarded a major telephone network contract to a joint US-UK venture, run by an American entrepreneur, Ehsanollah Bayat and two British businessmen, Stuart Bentham and Lord Michael Cecil.

“The plan was simple” Davis said. “Because the Taliban wanted American equipment for their new phone network, this would allow the FBI and NSA, the National Security Agency, to build extra circuits into all the equipment before it was flown out to Afghanistan for use. Once installed, these extra circuits would allow the FBI and NSA to record or listen live to every single landline and mobile phone call in Afghanistan. The FBI would know the time the call was made and its duration. They would know the caller’s name, the number dialled, and even the caller’s PIN.”

But the plan, Operation Foxden, was delayed by a turf war, during which “the FBI and the CIA spent more than a year fighting over who should be in charge”, he said.

The operation was eventually given the green light on 8 September 2001 – three days before the al-Qaida attacks. “A huge opportunity was missed,” Davis said.

He added that when Bentham and Cecil sued Bayat in the New York courts, and Bayat lodged a legal claim against the two Britons, the case was struck out and all records removed from the courts public database on the grounds of State Secrets Privilege, a legal doctrine that permits the US government to shut down litigation on the grounds of national security. The Britons attempted to sue in London, Davis said, but the case failed because “so long is the reach of the American State Secrets Privilege” that they were prevented from discussing key details of the US case.

“Through heavy-handed use of State Secrets Privilege, US agencies can dictate what British judges in British courts are entitled to know, and how much British citizens in British courts are entitled to say,” Davis told MPs. “What chance did Bentham and Cecil, or anyone else in a similar position, have of getting a fair hearing when American intelligence agencies can shut down cases without explanation in the US, and use State Secrets Privilege to control what evidence courts can see in the UK?”

Davis said that when he talked about this episode with “someone in the know in one of the agencies involved” he was told: “Ten years have passed, and the culpable people have retired or moved on, so it’s no longer embarrassing.”

Davis said the British green paper proposals are “more Draconian than State Secrets Privilege”, and added: “Giving a government agency an absolute right to secrecy encourages bad behaviour.

“This is the same State Secrets Privilege, and same American government, that the British green paper on Justice and Security is designed to protect,” Davis said, adding that the case demonstrates “how intelligence agencies misuse these laws, not to protect our security, but to avoid their own embarrassment and cover up criminal activity.”

Bayat has previously denied that he or any of his companies acted unlawfully and said that they have never acted as “an agent, informant or spy”. He could not immediately be contacted to comment on Davis’ speech.

The foreign officer minister Jeremy Browne told MPs: “The green paper proposals will enable better scrutiny [of government], which is a vital element in a healthy democracy.” He added that proposals are “not about covering up embarrassment, it is about enabling the work of the courts”.

Reprieve’s Executive Director, Clare Algar, director of the legal charity Reprieve, said: “This demonstrates just how ready the intelligence services are to cry national security in order to cover up their own embarrassment. It is yet another compelling example – if one were needed – of why we cannot let the UK Government’s plans for secret justice go ahead.”